China’s stumbling stock market

The Chinese economy continues to stumble. The pace of fizzling out from staggering growth has been steeper than expected. Few now think the second largest economy, which previously saw double-digit growth, is a threat to the U.S., the world’s largest economy.

To get back on the steady path for growth, the Chinese economy must combat several problems. Its debt should be first. Public debt ballooned astronomically after Beijing kept up a stimulus program of nearly 4 trillion yuan ($602 billion) to fight the 2007-2008 financial crisis. The biggest worry is corporate debt. Households have accumulated enough savings to afford their debt. The government deficit is also passable. The debt of Chinese enterprises, however, hovers at 163 percent of the gross domestic product, higher than the 109 percent of the Korean corporate sector during Asia’s 1997 financial crisis.

If the economy slows and corporate earnings are hurt amid heavy debt, the debt would sour. Ominous signs already are there. Non-performing loans of China’s commercial banks made up 2.15 percent of total lending by the end of May and delinquent loans reached 2 trillion yuan, the highest since 2010. The International Monetary Fund deems the bad loan ratio actually would be much higher at 5 percent. Beijing authorities have begun to regulate lending practices, and constraint on loans could further stall growth that hinges on corporate spending and investment.

Another worry is the real estate market. Property values jumped on policy rate cuts and the stimulus package. New home prices in 70 cities rose compared to May of last year and trading has been active. The market activity, however, is feared to chill out in the second half due to concerns over a price bubble. The appreciation in property values in major cities like Beijing and Shanghai has spilled over to periphery urban areas. The gap between housing values and income has widened. Home values in China are 25.7 times the average household income, the fifth highest among 95 countries.

Beijing has been using real estate to leverage the economy. Real estate investment takes up a third of total investment in fixed assets. Property takes up 60 percent to 70 percent of Chinese household assets. Considering that the real estate sector contributes to 13 percent of growth in the Chinese economy, a market slowdown could mean bad news.

The other challenge is restructuring. The Chinese economy is weighed down by overcapacity as the result of decades of investment and expansion. Surfeit is common across the industry with steel, coal, glass, and concrete being most bulged. Factory operation rate hovers at 70 percent, taking toll on profit. The gross profit of Chinese state enterprises was reduced by 24.6 percent from 2014 levels. Profit of the nonstate sector also fell 1.4 percent. China proved the textbook theory that an economy gets into a trouble when more than 40 percent of growth is propelled by investment.

The Beijing government has been carrying out restructuring to address the problem. President Xi Jinping has made reform and streamlining a state agenda. Since corporate restructuring inevitably accompanies layoffs and job insecurity, consumption would be dampened, raising the downside risk for the economy. The government has been making fiscal assistance through extraordinary budgeting, but its endeavors won’t likely provide much relief. Reinforcing social security is necessary, but it takes time for such system to bear fruit.

A slowdown directly affects stock performance. The Chinese stock market movements can influence Korea’s capital market as China takes up more than 30 percent of Korean offshore exposures via fund investment. Since opening in 1992, the Chinese bourse has been on a roller-coaster ride, refreshing bottoms over a lengthy period. Chinese shares, having hovered around new bottoms for a long time with little incentive, tend to skyrocket upon an impetus. The move in 2014 to connect the Shanghai Stock Exchange and Hong Kong Stock Exchange was a major boost to shares that have been on a downward trend for nearly seven years. The composite index rallied to near 5,000.

The Chinese stock market is in a correction period after a dizzy ride. Shares are likely to stay subdued for a long time due to the slowdown in the underlying economy. The Chinese market is usually late in factoring the downside or upside. Investors take more time to make a judgment and trade due to skepticism in corporate earnings. Shares are likely to move unrelated to the underlying corporate performance. The Chinese share in the global economy has been growing, but its influence has waned from its past. Foreign capital has been moving back toward the emerging markets since the British decision to exit the European Union, but not much is likely end up in the Chinese stock market.

Translation by the Korea JoongAng Daily staff.

JoongAng Sunday, July 31, Page 19

*The author is the head of the IBK Securities research center.

Lee Jong-woo